Mark Northwood, global head of equity trading at Fidelity Worldwide Investment, has a degree in mechanical engineering from Imperial College in London. His degree has become increasingly useful in his job as advances in technology have led to the investment process becoming more like engineering.
The ability to analyse code and use data is likely to become as important for traders as their ability to analyse markets. For example, the increased speed of trading has led to order books in more liquid stocks turning over so quickly that traders have no choice but to rely on algorithms to interact with them.
Northwood told Markets Media: “The traders who have been in the business a long time still retain the ability to negotiate large trades, to read markets, to understand when prices are moving for reasons other than fundamentals, and they are still very valuable. But the fact that markets are almost entirely computerised these days means traders need to hone analytical skills and an understanding of more quantitative trading models because so many other market participants are using them.”
For example in both London and Asia, Fidelity Worldwide Investment traders closely collaborated with sell-side firms to develop specific behaviours within algorithms to reflect the firm’s trading style and objectives and integrate some bespoke technical signals.
“The firms which have been labelled high-frequency traders, a sub-set of whom are genuinely making markets, are able to detect and react to small changes in demand and supply incredibly quickly, so it is hard to trade much in a lit venue without impacting prices. That is an issue and the reason why institutional investors have been vocal supporters of retaining the choice to use dark pools,” said Northwood.
Cap Concerns
The proposed MiFID II regulations place volume caps on trading in dark pools of 4% of daily volume in an individual stock on any single venue and 8% of total average daily volume in aggregate from 2017. There are waivers for large-in-scale orders and trading in auctions.
Northwood said concern has rightfully been raised on the double volume caps, particularly as dark volumes in many European names are already close to these levels. “My personal view, as someone who is not actively trading any more, is that the caps may actually encourage a return to the intended use of dark pools – for matching large trades that are bigger than the lit quote size – which will be helpful to institutional investors,” he added.
His preference would have been for the market to evolve that way naturally instead of having arbitrary limits imposed. “The reason that we have tiny trades being done in dark pools is because traders have experienced too much price impact by being in the lit venues, and because most algos are calibrated to trade in tiny slices,” said Northwood.
Exchanges are launching initiatives to help the buy side trade large blocks in lit venues. The London Stock Exchange has said it will begin a midday auction late this year. Aquis Exchange, the subscription-based venue which launched in 2013, has launched a new order type to give members cheaper access to closing auctions across Europe.
A white paper in April from broker Neonet Securities and LiquidMetrix, the analytics firm, said: “With the focus of buy- and sell-side communities on MiFID II, intraday auctions may provide an alternative option in the perennial search for liquidity. They could also provide an alternative to dark pool trading, especially as such trading is set to be capped under the new MiFID II proposals.”
Northwood said: “The auction model is being embraced by the market and whether there are trigger points other than the close, is something which can be explored. The workflows at every institution are different and there is a fair bit of work required to accommodate additional spot or even scheduled auctions.”
In the book Flash Boys, bestselling author Michael Lewis claimed that equities markets are rigged in favour of high-frequency traders.
“For many in the industry there is a sense that we don’t have the ideal equity market structure today,” added Northwood. “But it certainly isn’t broken and it functions efficiently for many participants.”
In March Fidelity Worldwide Investments was one of the four asset managers – alongside AXA Investment Managers, Union Investment, JP Morgan Asset Management – who joined Plato Partnership, the consortium creating a not-for-profit equities trading utility in Europe. Plato was set up to make it easier for institutions to trade large blocks of shares with less market impact. The trading revenues will be used to fund academic research to improve market structure by identifying better ways of executing trades, lowering the cost of trading and improving the execution lifecycle.
Northwood said: “Our participation in the Plato initiative is driven by our desire to be directly involved in the thinking about future market structure and the concept of using revenue generated from the trading process to fund market structure research is an exciting one that we support.”
Fidelity Worldwide Investment is not presently a member of any trading venues so their orders are routed through investment banks or brokers. “Of course, we have discretion and control over which venues are included and some of the rules of engagement in each destination and a core part of our process is to manage that on an ongoing basis,” he added.
SWF View
In a paper in April Norges Bank Investment Management, which manages the world’s largest sovereign wealth fund, said liquidity pools play an important and beneficial role in modern equity markets. However there should be greater transparency around from both dark pools and exchanges around order types and their matching priority. “Norges Bank Investment Management favours the development of utility-like, transparent and simple block crossing venues,” said the paper.
Northwood has been at Fidelity Worldwide Investment for 15 years and during that time the commission model has been unbundled, where rules permit. He argues this means that brokers are not chosen based upon commission targets, or on direction from a fund manager, but by judging which counterparty can achieve the best outcome when executing an order. For a mid-cap Italian stock, Fidelity Worldwide Investments would consider using an Italian broker as an alternative to a large global firm. For certain types of order, particularly those which are large-in-scale, the firm will try to execute without going to a lit venue at all.
“The much maligned indication of interest still features in the selection process and how that part of the business is governed is of growing importance to us,” said Northwood. “We expect investment banks to manage the distribution of IOIs intelligently, based on each firm’s response rates and typical order profile.”
For example, Northwood’s team would not look favourably on sellside firms that send French small-cap IOIs to clients who only send that bank UK large-cap orders.
“We consider that our evaluation of a firm’s algos and smart router performance informs us about all of our trading with them as their traders use similar tools, so this is important,” he said.
The proposed MiFID II regulations place more emphasis on best execution policies which need to be customised according to asset class across equities, fixed income, foreign exchange and derivatives. Fund managers will have to inform their clients how they choose venues, the execution strategies they use, procedures used to analyse execution quality and how best execution is monitored and verified.
Northwood said: “In Europe the regulators have made it very clear that they feel that existing execution policies on both the sell side and buy side aren’t up to scratch.”
He added that Fidelity Worldwide Investment’s execution policies vary with order type and market conditions so firm is discussing how to describe those differences in more detail while being aware that this information will be made public. The firm is also discussing how to adopt target benchmarks for particular orders.
“We have debated this point for many years – whether to formally benchmark or not, and aligning this with the interests of our investors – and we recognise that our execution process should include some clearly defined benchmarks for assessing performance,” said Northwood.
To help measure best execution, Fidelity Worldwide Investment is focussed on harmonising and enriching trade reporting in FIX to include the attributes of every child order and trade.
“To enable proper evaluation of algo performance we want to capture the order type used, whether a print was passive or aggressive, the quote spread, where the order was routed, if matched or cancelled, whether it was a dark book, and details about the current algo settings. This is a big task,” he added.
Trade Reporting
Northwood is supportive of initiatives such as making Market Model Typology compulsory for trade reporting of over-the-counter European equity trades. In February last year the Federation of European Securities Exchanges and FIX Trading Community said MMT has become a FIX standard to allow standardisation in data from trading or trade reporting venues to create a European consolidated post-trade tape. Bats Chi-X Europe was the first exchange to announce it would incorporate MMT.
Mark Hemsley, chief executive officer of Bats Chi-X Europe, told Markets Media this year: “MMT provides a tremendous set of data for traders to assess interactable liquidity and for regulators to see why orders were executed OTC. MMT will also force exchanges to report their on-book trades in a standardised way.”
Northwood is also interested in standardising the metrics for trading cost analysis, especially around what happens before and after individual child orders. “We have looked at a number of TCA products and we work with our counterparties to standardise the analysis they give to us such as fill rates and reversion statistics,” he said.
Fidelity Worldwide Investment is using Trade Informatics as a new TCA provider and preparing to send them full FIX data to analyse detailed elements of their algo trading.
“The algo trading that we choose to direct ourselves is between 25% and 30% of our business,” Northwood added. He believes this is probably lower than peers, reflecting Fidelity Worldwide Investment’s bias in order flow towards mid-cap and small-cap stocks.
“Another priority is “TCA-plus” or taking the traditional analysis of order implementation and expanding that to optimise trading strategy to a list of execution factors beyond the original MiFID list. We want to track why certain trades went well or not so well and if there are common factors which would guide us to trade differently in the future,” he said.
The equities trading team has 10 traders based in London, including a head trader for EMEA and a head trader for Americas, and 10 traders in Hong Kong including a head trader covering Asia-Pacific, who are organised geographically. Northwood reports to Dominic Rossi, global chief investment officer, equities.
“We tried sector trading in Europe a few years ago but the adverse effect was that relationships with our regional and specialist brokers suffered,” added Northwood. “We were effectively asking a Spanish firm to build a relationship with not one, but seven of our traders and that didn’t work.”
There is a separate trading team for fixed income and foreign exchange led by Andrew Falco, head of trading, fixed income. As fixed income trading becomes more electronic it is possible that, one day, the trading teams could converge.
“It is apparent that the fixed income world will have to deal with a lot more transparency than it is used to,” said Northwood. “In the equities world we have lived with transparency for a long time so we can share our experience”
At the end of March this year Fidelity Worldwide Investment had $284.7bn of assets under management, up from $275bn at the end of last 2014. The firm does not publicly disclose the breakdown by assets or geography.
Fidelity Worldwide Investment was established in 1969 as the international arm of Boston-based Fidelity Investments. It became independent of the US organisation in 1980 and is owned mainly by management and members of the original founding family.
In December 2013 Fidelity Worldwide Investment moved to a new order management system and the equities team implemented the Charles River OMS to replace a proprietary system and has just completed an upgrade to the latest version.
“On their desktop traders tend to have a bunch of different applications jostling for position on screens and the vision we have is that the highest priority information appears in a central dashboard view,” said Northwood. “We are quite excited at seeing the new version of Charles River as it has the technology which allows us to bring relevant external information into the desktop more easily.”
Northwood said he would like to see a more dynamic view of the firm’s trading. He added: “The model that we are building towards is that given a particular set of orders, we have a predicted path that we will follow so we can be very focused on deviations from that. If something happens that we don’t expect, then that is flagged and we react immediately, as opposed to trying to resolve things later.”
His engineering background came back to the fore as he eulogised on the benefits that technology can bring. Northwood said: “The evolution continues but the revolution is what technology can deliver. Within the financial world as elsewhere, the firms that have been most disruptive are often small or start-ups who can be genuinely agile. Large institutions need to recognise the benefits technology can bring their process and embrace them. There is much more to come.”
Featured image via Dollar Photo Club